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Sunday, December 12, 2010

Economic Outlook: Making Money When Others Aren’t

Economic Outlook

Making Money When Others Aren’t

By Avery Shenfeld

Only dividends are yielding above the long-term average
These may not be the toughest economic times we’ve seen, but a lot of us are still having a tough time making money. That’s not only true for some in the labour market, where Canada’s stubborn unemployment rate looks good only because America’s is so much worse. But it’s also true for investors, particularly for pension funds that have traditionally used safe, fixed income assets as the core of their portfolios.
At the short end of the curve, fixed income returns will be abysmal for the next year at least. We see no end in sight to zero short rates in the U.S. Before the Federal Reserve even thinks about raising rates, it will have not only delivered another dose of quantitative easing, but started the process of mopping up the extra money by sending bonds back to the market, and perhaps raising the rate on excess reserves. With so many steps to come first, we’ve pushed back the move off of a zero funds rate beyond 2012.
That softens the outlook for the Bank of Canada, which has to be concerned about the impact of much wider spreads on the Canadian dollar, and the resulting drag on exports. The pause at 1% could last until the second half of 2011, and another long pause at 2% in 2012 could be in the cards. Closing the output gap by the end of 2012 does not, as some assume, imply that rates go back to some fixed “neutral” level over the same period. Rates could stay low to the benefit of the economy, but to the detriment of T-bill investors, if needed to offset a weak external environment.
Longer bonds benefited from the capital gains associated with the recent rally, but that party may be over soon. You don’t want to buy what the Fed is buying, or its close substitutes (Canadian sovereign debt), since prices are being pushed to artificial highs by the Bernanke bid for bonds, and will snap back when quantitative easing is unwound down the road. The stretch for yield in bonds may also have sapped the juice out of high-yield corporate debt.
That leaves equities as the refuge from the low growth, low return environment. Typically, stocks are flying when the economy is too, but reliable dividend-paying equities stand out in a non-recessionary, but slow growth world. Cashing dividend cheques, as opposed to pay cheques or bond coupons, may be the best way to make some money when others aren’t.
Only Dividends Still Above Long-Run Average (as at Sept. 30, 2010)
 
Avery Shenfeld is chief economist at CIBC